Edited version of private advice

Authorisation Number: 1051806977987

Date of advice: 18 March 2021

Ruling

Subject: Division 7A

Question

Will the release if the UPE give rise to a deemed dividend under Division 7A of the Income Tax Assessment Act 1936?

Answer

No

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20YY

The scheme commences on:

During the year ending 30 June 20XX

Relevant facts and circumstances

1. X Co is an Australian private company.
2. The Y Trust made unpaid distributions (UPEs) of income to X Co over several years prior to 16 December 2009.
3. The Y Trust and X Co both quarantined the pre-16 December 2009 UPE balance in their accounts. The pre-16 December 2009 UPE balance has not changed.
4. The UPE has not been converted to a debt.
5. The Y Trust held shares in a company (Z Co).
6. In a prior income year The Y Trust sold the shares it held in the Z Co to an unrelated, arm's length purchaser.
7. The shares were sold for a substantial loss, resulting in a deficiency in the Trust's net assets.
8. The shares were sold at a loss due to a fall in their market value. The loss was not caused by an act or omission intentionally or negligently done by the trust and there was no breach of trust the trustee was required to make good.
9. X Co is proposing to release the Trust from payment of the UPEs on the basis that it has no ability to pay them.
10. It is assumed at the time of the proposed release:
    1. The Y Trust's only asset will be shares in X Co.
    2. X Co's only asset will be the pre-16 December 2009 UPEs owed to it by the trust.

Relevant legislative provisions

Income Tax Assessment Act 1936, section 109C

Income Tax Assessment Act 1936subsection 109F(1)

Reasons for decision

Summary

The release of the UPE by X Co will not give rise to a deemed dividend under Division 7A of the ITAA 1936.

Detailed reasoning

Payments treated as dividends

Section 109C of the Income Tax Assessment Act 1936 (ITAA 1936) sets out when a private company is taken to pay a dividend for the purposes of Division 7A of the ITAA 1936 and sets out what constitutes a payment for these purposes:

Section 109C

Payments treated as dividends

When private company is taken to pay a dividend

(1)       A private company is taken to pay a dividend to an entity at the end of the private company's year of income if the private company pays an amount to the entity during the year and either:

(a)    the payment is made when the entity is a shareholder in the private company or an associate of such as shareholder; or

(b)    a reasonable person would conclude (having regard to all the circumstances) that the payment is made because the entity has been such a shareholder or associate at some time.

...

109C(3)

What is a payment to an entity?

(2)       In this Division, payment to an entity means:

(a)    a payment to the extent that it is to the entity, on behalf of the entity or for the benefit of the entity; and

(b)    a credit of an amount to the extent that it is:

(i)            to the entity; or

(ii)           on behalf of the entity; or

(iii)         for the benefit of the entity

(c)    a transfer of property to the entity.

Taxation Determination TD 2015/20 Income tax: Division 7A: is a release by a private company of its unpaid present entitlement a 'payment' within the meaning of Division 7A of Part III of the Income Tax Assessment Act 1936? (TD 2015/20) further clarifies that a release by a company of its UPEs constitutes a 'payment' for the purposes of Division 7A of the ITAA 1936:

1.    Yes. A private company that releases all, or part of its unpaid present entitlement (UPE) credits an amount within the meaning of that word in paragraph 109C(3)(b) of the Income Tax Assessment Act 1936 (ITAA 1936). Such a crediting is taken to be a payment for the purposes of subparagraph 109C(3)(b)(iii) to the extent that the release represents a financial benefit to an entity.

Therefore, the release of the UPEs by X Co will constitute a payment for the purposes of Division 7A of the ITAA 1936 to the extent that the release provides a financial benefit to The Y Trust.

Financial benefit

As confirmed by TD 2015/20, the release of a UPE is a payment only to the extent that a financial benefit is conferred on the entity to which the UPE is released:

29. Nonetheless, it is considered that the release of a UPE (that ought to be properly reflected by a credit entry in the private company beneficiary's books of account) is a credit of an amount that is typically for the benefit (whether in their own capacity or not) of the entity to whom the UPE is released. Accordingly, the release of a UPE is a payment within the meaning of subparagraph 109C(3)(b)(iii) to the extent it represents a financial benefit to an entity.

...

33. In the context of subparagraph 109C(3)(b)(iii), the word 'benefit' means something which is capable of being enjoyed and which has a monetary value (that is, a financial benefit).

34. The release of a UPE is a payment for the purposes of subparagraph 109C(3)(b)(iii) only to the extent that a financial benefit is conferred on the entity to which the UPE is released.

Paragraphs 35 and 36 of TD 2015/20 go on to state:

35. If a trustee has lost the ability to satisfy a UPE due to circumstances beyond their control so that the beneficiary has no cause of action against the trustee to recover that loss (examples may, in certain circumstances, include loss caused by natural disaster, an economic market fall, liquidation of a debtor, or fraudulent or criminal actions of a third party), the release of the UPE does not confer a financial benefit on the trustee. This is because the release confers nothing upon the trustee of a monetary value that is capable of being enjoyed.

36. However, if the beneficiary does have a cause of action against the trustee to recover the loss, any release of the UPE ordinarily confers a financial benefit upon the trustee because the trustee's exposure to make good the loss is extinguished. In such circumstances, the extinguishment of that exposure is a payment within the meaning of subsection 109C(3). The effect of this is similar to the effect of subsection 109G(4) in respect of debts forgiven in similar circumstances.

Paragraphs 8 to 12 of TD 2015/20 provide an example where a trust owes a UPE to a company. The trustee in the example made investments using proper care and skill, however the investments became worthless due to a market fall. The loss was not caused by an act or omission intentionally or negligently done and there was no breach of trust the trustee was required to make good. In this example, TD 2015/20 states that the release of the UPE did not confer a financial benefit on the trustee and accordingly, the release is not a payment.

Similarly, in your circumstances, the trust sold the shares to an unrelated, arm's length purchaser and made a loss on the sale of its investment due to a fall in the market value. This was not caused by any intentional or negligent act or omission of the trustee nor a breach of trust which the trustee was required to make good and the beneficiaries do not have a cause of action against the trustee for the loss. Therefore, in accordance with TD 2015/20, the release of the UPE will not confer a financial benefit to you and will not be a payment within the meaning of subparagraph 109C(3)(b)(iii).

Forgiven debts treated as dividends

Under subsection 109F(1) of the ITAA 1936 a private company is taken to pay a dividend at the end of the private company's year of income if all or part of a debt the entity owed the private company is forgiven in that year and either the amount is forgiven when the entity is a shareholder or an associate of a shareholder in the private company, or, a reasonable person would conclude that the amount is forgiven because the entity has been such a shareholder or associate at some time:

Forgiven debt treated as dividend

(1)  A private company is taken to pay a dividend to an entity at the end of the private company's year of income if all or part of a debt the entity owed the private company is forgiven in that year and either:

(a)  the amount is forgiven when the entity is a shareholder in the private company, or an associate of such as shareholder; or

(b)  a reasonable person would conclude (having regard to all the circumstances) that the amount is forgiven because the entity has been such a shareholder or associate at some time.

Note: In some cases forgiving a debt does not give rise to a dividend. See section 109G

Section 109F will not apply to the proposed release of the UPE by X Co as the UPE has not been converted to a debt.

Conclusion

The release of the UPEs by X Co will not give rise to a deemed divided under Division 7A of the ITAA 1936.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).